Exactly three years ago yesterday, the president signed into law the Wall Street Reform and Consumer Protection Act to fix the conditions that led to the subprime mortgage meltdown and the Great Recession. This bill, also called Dodd-Frank after its sponsors, should have been called the "No More Meltdowns" or "No More Bailouts" act, because that was its essential purpose.
Unfortunately three years later, our financial system is not much more resilient. Much of the law has yet to be fully implemented, due to unceasing lobbying by the banking industry. Fortunately, last week brought several signs of progress for those who want a stable and sustainable banking system that serves all Americans.
The first bit of good news is the confirmation of Richard Cordray to head the Consumer Financial Protection Bureau. Cordray's approval is particularly important because the Bureau was barred by law from exercising its full powers until its director was confirmed. (This, of course, created an irresistible opportunity for those who opposed its existence anyway.) Now, with Cordray firmly in the saddle, the Bureau can take overdue steps to improve mortgage lending: It is empowered to preventing mortgage originators from steering borrowers into grossly inappropriate products, from concealing the true cost and risks of mortgage products and from forcing borrowers into bankruptcy by stalling on routine modification requests. These three functions are crucial to protecting the integrity of the overall mortgage system and protecting taxpayers from future bailouts.
Another welcome development is a new requirement that so called "systemically-important" banks keep additional capital on hand to protect them from speculative bets gone bad. These "too big to fail" banks – like Chase, Wells Fargo and Bank of America – are the most dangerous to the rest of the economy. The new rule would make them retain a cushion of 6 percent of assets, a substantial increase over present levels.
The proposal to raise capital requirements was issued by three major regulatory bodies in unison: the Federal Deposit Insurance Corporation, the Federal Reserve Board and the Office of the Comptroller of the Currency. It's always good news when major regulators with overlapping jurisdiction agree in public, rather than undermine each other over policy issues or to protect turf.
The new capital requirements would inject about 36 percent more capital, on average, onto the balance sheets of major banks, according to analysts. That means the next time bankers make a serious mistake, (like, say, assuming a AAA rated mortgage-backed security is actually a safe investment) the bank has more money to cover the loss before taxpayers feel the pinch.
A third sign of progress is that pressure for change is now coming from both Democrats and Republicans. This sways public opinion to support reform and gives regulators more backbone to resist pressure from industry. A lot of the tough questions lately have come from the tag-team of Sens. David Vitter, R-La., and Sherrod Brown, D-Ohio. Together, these two have proposed reforms much tougher than anything in Dodd-Frank.
Vitter and Brown are not alone in their calls for action. Two weeks ago Republican Sen. John McCain, his party's presidential nominee five years ago, joined with freshman Sen. Elizabeth Warren, D-Mass., and two others to announce the "21st Century Glass-Steagall Act," which calls for complete structural separation between federally insured bank deposits and the leveraged speculation that banks do with their own capital. This proposal goes much farther than Dodd-Frank in separating these activities.
Finally, some of the pressure for reform is now coming from Ben Bernanke. Appointed by former President George W. Bush to chair the Federal Reserve, Bernanke cannot easily be dismissed as a regulatory zealot from the Obama administration. Threatening further action if the Dodd Frank measures are not implemented successfully, Bernanke told Congress that "additional steps would be appropriate".
The banks and their lobbyists have been complaining that they can't afford to comply with Dodd-Frank or to commit more capital, but their credibility is undercut by an unlikely source: the banks' own soaring profitability. America's six largest banks reported $23 billion in profits in the second quarter, a record for any quarter since the downturn began. Goldman Sachs' profits for the second quarter of 2013 were about twice what they were for the same quarter a year ago. Clearly, banks' compliance with Dodd-Frank has not impaired their profits. Further, U.S. banks don't seem to have lost business to other nations with looser regulation.
Unfortunately, while banks' profits have risen, lending has lagged. This holds back the recovery and limits hiring in the rest of the economy. After all, the main reason that a society needs banks in the first place is to lend money so businesses can start or expand, and consumers can finance major purchases. Banks have throttled back on their lending because they can (for now) make more money on trading derivatives and other securities.
But why should the government give banks special privileges, such as deposit insurance and extremely low cheap capital, if the banks are not going to meet the capital needs of the Main Street economy? The combination of record profits and lagging loans suggests that banks, left to their own, are not getting back to the basics of lending. Banks need more regulation, not less, to refocus them on providing liquidity where it's needed.
The events of last week were a good start. But we have a long way to go before we can put the problems of the past behind us. Derivatives trading is still too opaque. Speculative investing has not been separated enough from government-guaranteed deposits. Higher capital levels have not yet been approved and implemented. Until the guarantees implied by "too big to fail" are fully withdrawn, we can't rely on the fear of losses and bankruptcy to discipline the industry and dissuade bank executives from taking unwarranted risks with the public's money.
David Brodwin is a cofounder and board member of American Sustainable Business Council. Follow him on Twitter at @davidbrodwin.